Supply Chain Disasters

Article, Financier Worldwide – December 2012

Insurance / Property

Now, more than ever, with the increase in globalisation and offshore production, the stability of a global supply chain is paramount to the successful running of a business. Justin Crick, Partner and Mark Jennings, Manager at RGL Forensics London, consider how the spate of natural disasters over the past few years has brought into focus the dependence of a company’s bottom line figure on its suppliers, and has led to a re-evaluation of supply chains and disaster recovery plans.

Asia is a popular location for the establishment of manufacturing plants and as such many companies, whether they realise it or not, may find some part of their final product will depend on production on that continent. With access to cheap skilled labour, low overhead costs, taxation incentives and the highly integrated nature of industrial parks – where the end product of one entity is the starting product for the next – Asian supply chains can, and do, work.

However, the recent Japanese Tsunami and extensive flooding of Thai industrial parks have highlighted the vulnerabilities companies face when relying on suppliers. Munich Re, the reinsurer, estimates that these two natural disasters alone resulted in losses to the wider global economy in excess of US$380bn.

Take Toyota as an example. They had been the world’s leading car supplier by volume since 2008, but they have now relinquished their position at the head of the table to General Motors due to, in part, an inability to make cars resulting from a lack of components from damaged production lines. The electronics giant, Sony, posted huge losses caused, in part, by supply chain problems at their own and their suppliers’ damaged factories, resulting in losses throughout the majority of their product ranges.

Losses were also suffered by companies with no direct presence in the affected area. Interruption to one factory can lead to disruptions throughout the whole chain. Even the smallest supplier can create a significant impact, as seen with companies such as Apple, who suffered from a shortage of stock when a minor supplier’s factory was closed down due to the Tsunami in Japan.

Natural disasters in this region are not new phenomena. The Kobe earthquake of 1995 caused massive damage and disruption to the region – with losses estimated to be US$200bn. The business impact of the recent events mirror, to some extent, that observed after Kobe. One may have expected lessons to have been learnt, but that has not necessarily been the case with businesses now finding themselves in a similar predicament.

Understanding and awareness of the critical path of the supply chain is paramount, even more so as businesses migrate to just-in-time stock strategies, with limited buffer stocks, where even just a small delay in the receipt of raw materials can have serious knock-on implications. Management need to recognise the weak links in their supply chain and that of their suppliers’. It is important not to underestimate the significance of every supplier – from the largest to the smallest.

Those well placed, and with an element of luck, can emerge from such events in a better shape. For example, the impact of the Thai floods on the production of hard disk drives has been well publicised. World production decreased by some 30 percent during the final quarter of 2011 and resulted in Western Digital, the number one producer up to that point, dropping below Seagate into the number two position. Furthermore, producers were able to take advantage of supply shortages and increased prices accordingly.

In terms of risk management, it is not always possible, nor economical, to have multiple suppliers in multiple locations for the same product to reduce the risk that such disasters can pose. Insurance can provide some respite, but business interruption policies may not provide cover for all supplier issues – requiring damage to be physically sustained by the entity suffering the loss. Contingent Business Interruption (CBI) insurance, which provides cover for losses sustained when a supplier (or customer) is damaged, can provide some protection. Such policies are complex in nature and require an understanding of the weakness of the supply chain in order to be appropriately tailored. Typically, suppliers are named – but damage to a supplier’s supplier, and supplier’s supplier’s supplier (and so forth back down the chain) may not always be covered.

CBI insurance generally requires damage to be sustained to a supplier or customer. In the aftermath of the Tsunami in Japan, some companies’ facilities were required to stop production due to frequent power outages, road closures and the nuclear exclusion zone. Such events may not trigger CBI coverage, but additional coverage could be purchased to protect against such events – at an additional cost. There is also a wider consideration of reputation. When a supplier cannot deliver its products, the company’s reputation will, undoubtedly, be tarnished and may result in an ongoing financial impact.

The ever complex nature of supply chains have been underestimated and underappreciated in the past and the recent natural disasters in Asia have once again highlighted how a disruption in key manufacturing hubs like Japan and Thailand can impact businesses throughout the world. Supply chain risk management is key to running a successful business and all too frequently businesses have chased cheaper suppliers without appreciating the additional risk that this places on the long term profitability of the business. If insurance is sought to help manage supply chain risk, it is essential to ensure that the correct and adequate cover is in place.

Justin Crick is a partner and Mark Jennings is a manager at RGL Forensics. Mr Crick can be contacted on +44(0)20 7065 7904 or by email: jcrick@uk.rgl.com. Mr Jennings can be contacted on +44(0)20 7065 7928 or by email: mjennings@uk.rgl.com.